The more eurozone bailouts there are, the worse it will get

Have they still not worked it out? Can it really be so hard to grasp that the bail-outs make things worse, not better?

The main reason bail-outs are bad is that they destroy the functioning of capitalism and are an immoral mechanism to keep rich folk who, by rights, ought to lose some of their money. But there are other reasons why bailouts make things worse, very simple reasons that even terribly short-termist politicians who don't care about the ethics of debt or the functioning of economies should be able to grasp.

I've explained previously how the consequence of bail-outs has been that final rates of default on private sector creditors are much higher than they would be absent bail-outs. This is the issue of "subordination". Once the ECB or the eurozone bail out fund lends a country money, that country's private sector creditors are pushed down the pecking order. Bail-outs don't make a country any less bust. All they do is ensure that when the default occurs it is applied to a smaller proportion of the debt – the private sector debtors not paid off with the bail-out money. So the percentage losses for those that are left bearing the loss are higher. So bail-outs spare some folk who ought to lose some money from making losses and also force higher-than-necessary losses on others.

Since anyone daft enough to continue holding a country's debt is exposed to a greater loss when there is a bail-out, no one wants to hold that country's debt any more once it is bailed out. So the unsurprising consequence of being bailed out is that one is then shut out of private sector debt markets – at least until the bail-out money is repaid. The bail-out which policy-makers fondly believe ought to make bond yields fall and it easier for countries to borrow money has precisely the opposite consequence – when countries are bailed out their bond yields spike up and the appetite for their bonds falls. This is precisely what we saw in the case of Spain over the past few days.

The more bail-outs there are, the worse things will get. By bailing out Greece, policy-makers imposed larger losses on Spanish, French and other holders of Greek debt. By bailing out Spain, policy-makers will make Spanish bonds worth less with the consequence of imposing larger losses on Portuguese, Italian and French bondholders. At the same time the French and Italian governments are theoretically liable for a portion of the Spanish bail-out. That makes France and Italy less creditworthy in two ways – their banks are more bust and their sovereigns are more stretched. Now there is pressure to bail-out Italy in turn. How can the French and Germans not bail-out Italy if they've bailed out Spain? But by bailing out Italy they will increase the cost of any Italian default and thus make such a default more likely.

If there were an Italian default of banks or the sovereign, calling on French bail-out guarantees, the French sovereign would be in serious trouble. Shortly, the sovereigns and the state-backed banks may start defaulting on the official sector creditors as well as the private sector creditors. Greece first, if SYRIZA wins this weekend. Then perhaps the Irish banks. Once the Portuguese have defaulted on their private bondholders they may start thinking about the official sector creditors. And thus the same domino process of the bail-outs may see a cascade of sovereign defaults on official creditors.

The French may not wait to see whether that reaches Italy – if there starts to be any risk that French guarantees will be called on, the French may withdraw from the euro to avoid that (perhaps a little after countries such as Finland and Slovakia, who may start planning to leave not long after Greece defaults on official creditors). That would leave Germany holding the baby on the whole sorry mess. The Germans – with fellow-travellers such as Austria and Netherlands – may decide they, also, prefer to leave rather than to pay.

And thus it would be, as some of us warned from the start, that it was the bail-outs that destroyed the euro. Not bailing out countries was never a threat to the euro. Most analysis, from the beginning, had this precisely the wrong way around.